“Winter is coming”: Can Financial and Macroeconomic Variables Predict Crises?

Abstract

This paper focuses on the analysis of business cycles in a group of 11 Emerging European economies. The objective of this paper is twofold. First, we aim to test which macro-financial indicators provide the earliest warning signals of impending recessions for the selected group of countries using the signal method. We also test whether financial or macroeconomic group of indicators are able to catch the recession signals earlier using the Mann Whitney U Test. Second, to correctly identify the predicting indicators that emit early signals of incoming recessions, we aim to precisely identify the points in time when the business cycles entered the phase of recession, i.e. to pinpoint the turning points of business cycles in Emerging European economies. We thus implement the Bry-Boschan algorithm, adjusted for the quarterly GDP time series, to identify the dates of recessions in a selected group of countries more precisely, thus offering a methodological contribution to the literature. Our results indicate that the conventional and the BBQ method of identifying recessions correspond to a large extent, but not entirely, thus justifying the use of more sophisticated methods of determining turning points of business cycles. Our analysis shows that financial indicators offer earlier warning signals of impending recessions than macroeconomic indicators. We find that the most precise indicators for early signaling of impending recessions contain five financial and two macroeconomic indicators. Namely, the slope of the yield curve on euro bonds and on treasury bonds, the current account balance to GDP ratio, the real estate price index, yield on 2-year treasury bonds, the coefficient of self-financing of commercial banks and TED interest spread.